Banco Santander: Should You Buy This 9% Yielder?

| About: Banco Santander (SAN)

Banco Santander (NYSE:SAN) is a Spanish-based bank but has a global presence and high exposure to Latin America, which offers good growth prospects over the long-term. Currently, it offers a dividend yield of 9.3%, which is among the highest in the banking sector and is very attractive for income investors. However, as usual with high-dividend yields one has also to question its sustainability to assess if it is an opportunity or a dividend trap. Banco Santander has a market capitalization of about $97 billion, and is traded on the New York Stock Exchange.

Bank Overview

Banco Santander is a global, multinational bank based in Spain. It was founded in 1857and has nowadays about 187,000 employees across several countries. At the close of 2012, Santander was the largest bank in the eurozone and one of the thirteen leading banks in the world in terms of market capitalization. Based on a business model that focuses on retail banking products and services for private customers, small and medium enterprises [SME], and corporates, Santander currently serves more than 100 million customers through a global network of 14,400 branches, the largest in the international banking sector. It has about $1.9 billion in managed funds across its customer segments.

One of Santander's main positive factors is its business model, focused on commercial activities which generate stable and recurrent revenues over the medium-term. About 88% of its revenues come from retail baking, and 65% of its gross income comes from net interest margin. Another distinctive factor is Santander's prudent risk management. For instance, its exposure to the subprime crisis in 2007 was negligible, showing that it prefers to stick with its business model even if the whole industry is making huge profits from more risky bets. Its business is also focused on quality of service and customer satisfaction, enabling Santander to have a very good reputation. As shown during 2008, reputation risk is a key factor in relation to a bank solvency, as no one is able to survive a bank run. Santander as won several awards over the past few years, such as Best Bank 2012 award from Euromoney, which increases its international recognition and help to build a strong and sustainable brand over the long-term.

Geographically, Santander has a solid presence in ten countries in two continents, Europe and America, and businesses in more than forty markets. Santander is currently the main financial group in Spain, its country of origin, and in Latin America, a continent where its main markets are Brazil, Mexico, Chile, and Argentina. It also holds a significant position in the United Kingdom, Germany, Portugal, Poland, and the north-east of the United States. In addition to these main markets, it also offers consumer finance services in Scandinavia, the Netherlands, Austria, Italy, and Belgium.

Santander's profit is balanced between developed and emerging markets which contributed, respectively, 45% and 55% to the group's profit in the past year. Brazil was the major market accounting for 25% of Santander's profits, followed by Spain with a weight of 15%, United Kingdom accounted for 13%, and Mexico 12%. Santander's international expansion has been achieved through subsidiaries that are legally independent and autonomous in capital and liquidity. Its operations in Brazil (NYSE:BSBR), Mexico (OTC:GFRSF), and Chile (NYSE:BSAC) are listed, allowing local units to have the capital required to carry their activity autonomously. This also reduces contagion risk in times of crisis, reducing the group's overall systemic risk.

Operational Performance

Santander is one of the world's most efficient international banks measured by the cost-to-income ratio, which is around 48% and much lower than its European peers. It is able to achieve this efficiency through cost savings, such as the shared IT platform across its business units. Santander wants to increase its efficiency even further and is targeting savings of $2 billion by 2016, including merger synergies in Spain (integration of Banesto brand in Santander) and Poland.

Its leverage is relatively low, given that it funds most of its lending from customer deposits which is usually more stable than capital markets funding. Its loan-to-deposit ratio was 108% at the end of the third quarter of 2013, an acceptable level for a commercial bank and a strong improvement from the levels reported in 2008.

One of the major's weak point of Spanish banks, including Santander, is the credit quality of its assets. The country had a real estate bubble during the past decade, which burst in 2007 leading to high credit losses across the baking system. Since 2007 to mid-2013, Spanish banks booked about €250 ($334) billion of provisions in their accounts. The non-performing loans [NPL] ratio recently reached a new all-time high above 12%, and more provisions may be needed over the coming months. As expected, Santander had a significant exposure to real estate risk given that it is one of the country's major banks. Its cumulative losses since 2007 were about $34 billion, or 10% of its 2008 loan book. These losses are below the Spanish baking system average which stand at close to 15%, showing that Santander had above-average credit quality. In Spain, Santander's loan mix is 31% exposed to corporates, 28% to mortgages, 19% to small and medium enterprises, and only 9% to real estate. As its current exposure to real estate is relatively small, Santander should have already recognized the bulk of losses over the past few years. Therefore, Spain's financial sector restructuring phase should be in its final phase, leading to a much healthier banking system going forward. Santander's non-performing loan [NPL] ratio increased recently to 5.43%, but is below the financial sector's average ratio in almost all the countries in which it operates. The coverage ratio stood at 64%. In Spain, its NPL ratio is about 6.4%, well below the sector's average.

Regarding Santander's financial performance, the bank has reported relatively good results over the past few years taking into account the weak operating environment it has faced, especially in Spain. Santander's results have been affected by high-level of loan-loss provisions and writedowns, especially to cover its real estate exposure in Spain. In 2012, Santander had to set aside more than $25 billion of provisions as a result of the crisis in Spain and the economic downturn in other parts of the world. This compares to $16 billion in 2011 and only $9.5billion in 2008. Due to this high-level of provisions, Santander's profit was only $3 billion in the past year, a level that the bank believes it does not reflect its earnings potential and should increase considerably over the next few years as provisions get back to normal. During the first nine months of 2013, Santander's profit increased by 77% to $4.4 billion due to lower provisions. As the macroeconomic outlook is improving in Europe, Santander should be able to achieve strong growth over the next few quarters.

Regarding its profitability, Santander had a very high return on equity [ROE] ratio before the global financial crisis of 2008-09, between 15% and 25% which was among the highest in the banking industry. However, over the past few years its ROE has declined due to cyclical and structural impacts, and is now below 10%. Santander expects to recover to about 12-13% over the next few years, reflecting higher capital requirements that banks have nowadays compared to before the global financial crisis.


Banco Santander has paid a stable dividend over the past four years, despite its earnings volatility. Its annual dividend per share [DPS] is €0.60 ($0.81) since 2009. Contrary to most European companies that pay only one dividend per year, Santander pays quarterly dividends. At its current share price, Santander's dividend yield is 9.3%. Santander has also a scrip program, enabling its shareholders to choose to receive the dividend in cash or in new shares. In 2012, about 80% of the share capital chose to receive shares, which reduces Santander's cash outflows and increases its capital ratios leading to higher solvency. On the other hand, the dividend payout ratio has increased considerably over the past few years, and was exceptionally high in 2012 at 260%. However, earnings have declined due to cyclical factors and are recovering fast, which means the payout ratio will decline to more sustainable levels over the next couple of years.

Santander's dividend policy is also supported by its relatively strong balance sheet, which has enabled Santander to avoid state recapitalization in all countries it has operations. Its core capital ratio [core tier I] was above 11.5% as of 30 September, 2013, so the bank should be able to pass the stress tests scheduled for 2014 without raising more equity.


Santander offers a very high-dividend yield of 9.3% which is supported by its strong fundamentals, namely its diversified business portfolio, retail-focused business model, high efficiency, and strong balance sheet. Moreover, as the economic outlook in Spain and Europe is improving its loan losses should decrease over the next few quarters, leading to higher earnings and a more sustainable dividend going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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